Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

Last week’s U.S. news was dominated by the oral arguments before the Supreme Court of the United States (SCOTUS) on the constitutionality of the Patient Protection and Affordable Care Act (PPACA), also known more succinctly as the Affordable Care Act (ACA), or, simply, “Obamacare.”  Most of the news coverage revolved around legal issues, such as how to define a “limiting principle” that would distinguish health insurance from other goods and services.  A few of those analyses, including one by my colleague Nolan Miller at the University of Illinois, provided useful economic insights on these legal questions.

But what I have not seen much of – until now – is a careful analysis of the impact of repeal on the federal budget.  Yes, there is plenty of rhetoric around this topic, with Democrats arguing that PPACA saved money and Republicans arguing that it created a huge new entitlement.  But there has been very little careful analysis.

That changed today, when the Mercatus Center at George Mason University released a meaty new report written by Charles (“Chuck”) Blahous.  His analysis shows quite clearly that the Supreme Court now finds itself in the position of having an enormous impact on the long-run fiscal situation in the U.S.

As background, Chuck Blahous is one of two public trustees of the Social Security and Medicare trust funds, having been appointed to this post by President Barack Obama and confirmed by the U.S. Senate.  Previously, Chuck served all eight years of the G. W. Bush administration at the National Economic Council.  After spending over two decades in both the legislative and executive branches of the U.S. government, Chuck knows the ins and outs of federal budgets.  He is also widely respected on both sides of the aisle as a serious policy analyst.

In a nutshell, here is what Chuck’s careful analysis finds:

1. PPACA is expected to increase net federal spending by more than $1.15 trillion over the next decade.
2. PPACA is likely to add more than $340 billion, and perhaps as much as $530 billion, to federal deficits over the next decade.
3. Despite these realities, government scorekeeping rules lead to deep confusion over the fiscal impact, and have the effect of making PPACA appear less expensive than it really is.

How can this be?  In part, the law “relies upon substantial savings already required under previous law to maintain the solvency of the Medicare Hospital Insurance (HI) Trust Fund.  These do not represent new net savings … but substitutions for spending reductions that would have occurred by law in the absence” of this act.  There are other issues at play as well.

All of this is “public,” in the sense that it has been disclosed in scoring documents by the Congressional Budget Office (CBO). But the CBO is constrained to report the effect of government tax and spending programs according to various scoring rules – even when those rules deviate substantially from the likely political or economic reality.  Skilled politicians have learned to use these scoring rules to their advantage.

As Chuck points out in his paper:

“A full understanding of the ACA’s budget effects requires appreciation of the distinction between two important points:

1. CBO found that the ACAD would reduce federal deficits when a specific scoring convention was applied;
2. The same analysis shows implicitly that the ACA would substantially increase federal deficits relative to previous law.”

The paper is over 50 pages in length (including the helpful Q&A in the appendix), but is well worth a read if you want to know the details behind the calculations.

But if you don’t have time to read it, here is the bottom-line: “Taken as a whole, the enactment of the ACA has substantially worsened a dire federal fiscal outlook.  The ACA both increases a federal commitment to health care spending that was already unsustainable under prior law and would exacerbate projected federal deficits relative to prior law.  This is an unambiguous conclusion …”

Were the Supreme Court to strike down all or part of this Act, we should view it as an opportunity to revisit health care reform in a way that reduces, not increases, public spending.

As posted on Forbes yesterday …

In 1941, President FDR explained why he chose to fund Social Security through a payroll tax in as follows:

“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program”

For more than seven decades, FDR’s strategy has proven effective.  Talk to someone in or near retirement – even people who consider themselves small government conservatives – and you will often hear them state that they have a right to their Social Security benefit because they paid for it over their working life.

President Roosevelt knew that the key to the political sustainability of Social Security was the establishment of an entitlement mentality, and the key to establishing an entitlement mentality was the linkage between payroll contributions and benefits.  If Social Security were structured as a means-tested welfare-style program – that is, it if were financed by a progressive income tax rather than through payroll contributions – it might have never lasted this long.

Given this, it is important that President Obama and Congress have just agreed to extend the payroll tax cut and to continue to use budget gimmickry to turn Social Security into a partly general-revenue-financed program.

Here is how it works.  The 2% payroll tax cut reduces revenue to Social Security by about 15 percent.  But Social Security does not have a spare 15 percent of revenue lying around: rather, it is currently running quite close to break-even on a cash flow basis, and faces enormous long-run deficits.  To get around this, President Obama and Congress have decided to replace the lost payroll tax revenue by transferring money from general revenue (which derives primarily from the income tax) into the Social Security trust funds.

This budget gimmick has the short-term political benefit of making the Social Security trust funds seem unaffected by this tax cut.  But it also means that we are deviating substantially from FDR’s vision of a retirement program being paid for (on a pay-as-you-go basis) by participant contributions.  By moving down the path of general revenue financing of Social Security, we achieve the short-term “progressive” aim of increasing the degree of income-based redistribution (because income tax rates rise with income, whereas payroll tax rates do not).

But in the long-run, this has the potential to erode political support for the program.  By shifting the funding burden onto the income tax, the program starts to look more like a welfare program than a contributory social insurance program.

I am not the first to notice the irony of this.  My very good friend Chuck Blahous, who served eight years in the National Economic Council for President George W. Bush, and who was appointed by President Obama as one of two Public Trustees for Social Security, just released a paper explaining why this payroll tax cut is bad policy.  Among the seven reasons he provides is that doing so destroys the “historical Social Security compact.”  In a Washington Post article back in December, Dr. Blahous stated that these budget gimmicks are “a grave step for Social Security.”

This view is not limited to experts on the Republican side: the other Public Trustee of Social Security (a Democrat) – Robert Reischauer, the highly respected president of the Urban Institute — agrees with Dr. Blahous.  While Reischauer was more sympathetic to the tax cut, he also noted that it “could, if it continues for a substantial period of time, undermine one of the foundational arguments that makes the Social Security program inviolate.”

Perhaps the most succinct summary of the irony comes from Jason Fichtner, a Senior Research Fellow at the Mercatus Center and former Chief Economist and (acting) Deputy Commissioner for the Social Security Administration.  He summed it up the situation quite succinctly in an email to me by noting that “in 15 years we might look back on this time in history and discuss how President Obama, as a Democrat, was the president that started the path to killing Social Security.”

So, maybe President Obama really is the Damn Politician that FDR was worried about?

That is, somebody said something nice about a bipartisan US effort.  Given the partisan rancor in this country right now, I found it refreshing to read this piece in the New York Times.  Of course, it was by Bono, but he was writing about something he’s actually an authority on — the worldwide fight against AIDS.  This is a fight that we’re actually starting to win, and Bono chalks the success up to American leadership by the Clinton, Bush and Obama administrations.

Read it here:

http://www.nytimes.com/2011/12/01/opinion/a-decade-of-progress-on-aids.html

As I write this blog, President Obama and Congressional leaders have still failed to agree on a deficit reduction package that would provide sufficient political cover to allow a majority of Representatives and Senators to vote to raise the debt ceiling.  (If they manage to pull a rabbit out of a hat this weekend before this post goes public, you can view this as a “what could have been” post.)

 Last week, I pondered the impact of a failure to raise the debt ceiling on broader economic activity.  A few days later, my colleague George Pennacchi, in an interview, provided further detail about the economic impact (read it here).  If politicians decide that they do not want to skip interest payments, and if they do not want to shortchange senior citizens or the military, then we are going to have to pretty much make everyone else wait for their payments.  One group that has been largely overlooked in the discussion – state and local governments.

 An exception to the overlook is a report issued by Pew Center for the States.  They point out the direct and indirect ways that the failure to raise the debt ceiling could negatively and substantially impact state and local budgets.  A few examples they cite include delayed payments to states for the many programs for which there is shared budgetary responsibility, such as Medicaid.  Or delays in grants to state, such as for education.  More indirectly, if financial market concerns extend beyond U.S. treasuries, this could increase borrowing costs to state and local governments as well.

 In short, while most of the focus has been on the impact of the debt impasse on federal spending, it is important to recognize that this will also likely “trickle down” on states in the form of cash-flow / liquidity constraints. 

Here’s hoping that by the time this blog is posted, it is already out-of-date.

If you listen to our politicians these days, you hear a lot about the deficit, the debt, the debt ceiling and so on.  In other words, much of the talk focuses on the need to bring spending and revenue into balance, and rightly so.  And, sooner or later we’re going to do that.  We’ll address social security, either through raising taxes or reducing benefits or both, and we’ll do something about health care costs, although I’m not sure anyone has a good idea for exactly how.  Maybe we’ll get lucky and grow our way out of this mess while we still have our heads firmly stuck in the sand.

What I want to focus on today is what American government is going to look like when all is said and done, and the very different visions coming out of the Democratic and Republican camps.  Although others have talked about this, I think it is a point worth making again.  So, here goes.

Consider the following graph, which appeared earlier this year in a Wall Street Journal article by John Taylor.  Now, the Taylor article is not exactly flattering to President Obama, and I don’t mean to endorse his main argument here, just to adapt his graph for my own purposes. 

What we see here are graphs of government spending as a percentage of GDP under President Obama’s budget through 2021 as well as the House Budget based on Paul Ryan’s Roadmap budget that was passed in April.  Note where they end up.  The Obama budget heads toward a government that runs around 23 percent of GDP, our best measure of overall economic activity in the country.  The House/Ryan plan ends up closer to 20 percent.

In the longer run, these differences become more pronounced.  The CBO’s long-run projection for the Ryan plan have government spending decreasing to 17 percent of GDP in 2022 and continuing down to 14 percent of GDP by 2050.  (These numbers don’t count interest paid on the national debt.)  Projecting out the Obama budget, as far as I can tell, hasn’t been done.  However, the same CBO report has long-run budget projections under current law (as of June 2010, so the impact of PPACA (health reform) isn’t in there yet) have spending as a fraction of GDP at 22½ percent in 2022 and increasing to 28% by 2050.  Now, the recent Obama budget makes some effort to rein in spending over the medium term, so maybe it puts us on a trajectory toward a government that is, say, 24% of GDP.

All of this assumes that the plans can do something about the rate of growth in health care costs, so take it with a pound of salt.  Oh, and keep in mind that this is federal spending and does not include spending on state and local government. 

So, there you have it.  Sooner or later we’re going to have to start paying for what we’re spending.  The question is, do we want to have a government that spends less and provides fewer services, as in the Republican plan, or a government that spends more and provides more services, as in the Democratic plan.  Now, a government that spends 14 percent of GDP (not including interest) is smaller than anything we’ve had in the last 40 years.  But, it doesn’t seem crazy.  A government that spends 24% of GDP is at the top end of what we’ve seen, but again, not a radical outlier.  And yet, a 10 percentage point difference in what our government spends is something like $1.5 trillion.  So, these will be two very different worlds.

If whether you are a Republican or a Democrat or neither, the battles that are being fought over debt ceilings and entitlement reform are skirmishes in a war over the future direction of American government, and these are very different directions.

We found some amazing old footage of President George Washington and President Thomas Jefferson discussing the Social Security Trust Funds.  Enjoy!

Yes, I’ve written about the budget before, and perhaps I’m getting repetitive.  But it’s important, and surprising, so I’ll give it another go.  But nevermind President Obama’s recent release of a proposed budget for next year.  That document is already irrelevant!  Let’s start with the current budget. 

Current federal spending now is over  $3 trillion per year.  The deficit is $1.6 trillion.  The U.S. House of Representatives approved a plan to cut spending by $60 billion.  The Republicans chose not to change spending on defense and homeland security, nor entitlement programs like Social Security, Medicare, and Medicaid.  The problem is that then other discretionary spending must be cut for some government agencies by as much as 40%.  And yet that total $60 billion cut is only a drop in the bucket.  It cuts the annual deficit only from $1.6 trillion to 1.54 trillion!

My point is that you can’t get there from here.  First of all, it’s not wise to cast such a wide net, without thinking, making cuts of 40% or more to discretionary programs simply because they are called discretionary.  It means cuts to national parks, environmental programs, and federal employees who provide many public services people want.

Second, who says we need to leave defense and entitlements untouched?   Within just a few years, Medicaid will cost about $300 billion per year, Medicare will cost $500 billion, and Social Security will cost $800 billion, and defense $800 billion.  ALL of domestic discretionary spending will be only $400 billion.  By those round numbers, $60 billion from that last category is a 15% cut.   The same $60 billion cut proportionally from all of those categories would be only a 2% cut.  That’s what I mean by a drop in the bucket.

Anyway, that plan would still cut the deficit only from $1.6 trillion to $1.54 trillion.  The ONLY way to make any sizeable dent in the huge $1.6 trillion deficit is to look at all the current spending, not just at $400 billion of domestic discretionary spending, but at the $800 billion of defense spending, $800 billion of social  security, $500 billion of Medicare, and/or $300 billion of Medicaid.

And who says taxes are sacrosanct?  A $1.6 trillion deficit means we are spending more than our income, so one just MIGHT think that problem can be approached from both ends.

On Tuesday night, President Obama gave the State of the Union (SOTU) Address (transcript) before a joint session of Congress.  The speech drew upon imagery from the Cold War past in order to spur action regarding America’s energy policy.  “This is our generation’s Sputnik moment,” the President declared, and thus he will send a budget to Congress that invests “especially [in] clean energy technology, an investment that will strengthen our security, protect our planet, and create countless new jobs for our people.”  To deal with this “Sputnik moment”, the President set forth two goals: (1) become the first country to have a million electric vehicles on the road by 2015; and (2) get 80% of America’s energy from clean sources by 2035. 

(Not quite as inspiring as President Kennedy’s urging on May 21, 1961 that “this nation should commit itself to achieving the goal, before the decade is out, of landing a man on the moon and returning him safely to the earth.”  On July 20, 1969, Apollo 11 landed on the Moon and Neil Armstrong took his first step on the lunar surface.)

I have three issues with the President’s approach.  First, the wording of the goals in the SOTU Address needs to be parsed carefully in order to understand their meaning or lack of meaning.  For instance, does “electric vehicles” mean all-electric vehicles or do hybrids count towards that goal?  Similarly, what is the definition of “clean sources”?  Fortunately, in this case we have an answer later in the Address.  As the President admits, “Some folks want wind and solar.  Others want nuclear, clean coal and natural gas.  To meet this goal, we will need them all.”  However, ambiguity still exists because clean coal and natural gas technologies can be deployed with or without carbon capture and sequestration technologies.

Second, the President did not offer details about HOW to achieve these goals.  The Address includes references to investments in clean energy technology, but it specifies neither investment level nor investment horizon required to meet the stated goals.  He did not say, for example, $10 billion annually for 10 years.  If clean energy is really a priority for the President, and given concerns about the fiscal deficit, then clarity about the needed investment level would be helpful so that other programs can be identified for cuts in order to balance the budget.  Also, the President said that “clean energy breakthroughs will only translate into clean energy jobs if businesses know there will be a market for what they’re selling.”  I agree.  However, an efficient, well functioning market requires a price signal.  This brings me to my last point.

Third, the President did not directly address environmental policy when setting his goals.  If the President really means “low-carbon” or “no carbon” when he says “clean”, then the absence of a carbon policy in the Address becomes conspicuous.  Specifically, the President did not indicate if he would again push for a cap-and-trade bill.  Given the composition of the new Congress, a cap-and-trade bill or any other piece of legislation that puts either an explicit or implicit price on carbon emission seems politically infeasible.  To have a market for these clean energy technologies, where is the price signal going to come from?  

In their forthcoming book called “Accelerating Energy Innovation: Insights from Multiple Sectors”, Rebecca Henderson and Richard G. Newell look at lessons from the histories of innovation in other industries and implications for the energy industry.   The introduction says: “Taken together the histories point to three key factors as critical to accelerating innovation: (1) well funded, carefully managed public research that is tightly linked to the private sector; (2) rapidly growing demand; and (3) antitrust, intellectual property and standards policies that together promote vigorous competition and the entry of new firms.”

How many people would ‘demand’ electric vehicles at a high price, just out of the goodness of their hearts?  Or would that demand depend on the existence of a policy that raises the price of burning fossil fuels?

The President noted that when Sputnik was launched, NASA did not exist.  Yet, the Department of Energy has existed for many years, and America’s energy policy is still unclear and uncertain.

There is a bipartisan consensus among scholars and analysts of the Social Security system that the program is fiscally unsustainable.  As I, and others, have pointed out many times, there are only two solutions to this problem.  Either we reduce the lifetime benefits that people receive (e.g., by raising the retirement age, changing the benefit formula, etc), or we raise taxes.  To find a bipartisan solution, we will almost surely have to do some of both.

Last night in the State of the Union Address, President Obama said:

“To put us on solid ground, we should also find a bipartisan solution to strengthen Social Security for future generations. We must do it without putting at risk current retirees, the most vulnerable, or people with disabilities; without slashing benefits for future generations and without subjecting Americans’ guaranteed retirement income to the whims of the stock market.”

What to make of this statement?  One must read the key phrases carefully …

Let’s start with the easy one – the last one:

“without subjecting Americans’ guaranteed retirement income to the whims of the stock market” – no surprises here.  The President – like nearly every elected Democrat in Congress -  is opposed to personal accounts as part of Social security.  It would have been big news if he had not said this.  The fact that he said it just “checks the box” on what we already knew.

Now on to reading between the lines …

“without putting at risk” — notice that he is placing a priority on protecting benefits of 3 groups: (1) current retirees, (2) low income households, and (3) those receiving disability benefits from Social Security.  This is not surprising, and in fact is the “norm” in many recent reform proposals – including President Bush’s plan for “progressive price indexation” which would have protected both (1) and (2) and might have protected (3) depending on whether the new indexation would have been made to apply to the Disability Insurance program.  There are good economic and policy reasons – and even stronger political ones – to protect these groups.  So the President’s choice of protected groups is not surprising.

But notice what he did NOT say.  He did not say we could not reduce benefits, only that we cannot put these groups “at risk.”  So, now comes the debate over whether we can have any reductions without putting these groups “at risk.”  For example, if we made a technical change in the way we calculated the cost-of-living-adjustment, such as using a different version of the consumer price index (CPI) that is thought to be more accurate (relative to the current one that is thought to over-state inflation), would that qualify?  Even though such a change would result- over the years – in very large reductions in expenditures relative to current projections?

“without slashing benefits for future generations” – hmmmmm.  There are two problems interpreting this statement.  First, what does “slashing” mean?  Can we “trim” benefits, so long as we don’t “slash?”  What constitutes a benefit “slash” – a 25% cut?  A 5% cut?  A 0.01% cut?

Second, even if we define  “slash,” we have to ask, “slash relative to what?” Relative to currently scheduled benefits, or relative to what today’s retirees receive?  This matters enormously, since each successive generation of retirees sees average starting benefits rise with average wage growth.  If we interpret the President’s statement about Social Security benefits as being “relative to what today’s retirees” receive, we have a lot of room for meaningful changes to the benefit formula.  After all, President Bush’s progressive price indexation plan would meet this criteria.   In contrast, if President Obama’s statement is relative to currently scheduled Social Security benefits, then he has just promised us a huge tax increase.

Representative Paul Ryan (R) of Wisconsin gave the rebuttal to the speech.  The fact that he did not mention Social Security has raised some eyebrows (here and here), in large part because he has specific ideas about entitlement reform that he outlined in the Roadmap that has made him an emerging star in the Republican party.

Unfortunately, I predict that we may not learn much anytime soon about where this debate is heading.  After all, the President has to start running for re-election soon, so now may not be the time to tackle such a politically divisive issue.  Which is really too bad for future generations …

I try to be an intellectually honest economist.  As such, answers to complex policy questions such as whether we should raise taxes on the highest-income Americans should, I believe, depend on a number of empirical factors about the costs of taxation, losses due to decreased work incentives, and the benefits of redistributing wealth from rich to poor.  To my point of view, sometimes the costs and benefits line up in favor of lowering taxes, sometimes they line up in favor of raising taxes.  But, from a policy perspective, this is fundamentally an empirical question.

This is the reason why I find it so frustrating to listen to ideologues on the left and right who seem to know the answer to the question before looking at the facts.  And, this is why I found Greg Mankiw’s recent column in the New York Times to be so refreshing.  In the piece, Mankiw, who is a Harvard economist and chaired the Council of Economic Advisors under George W. Bush, made the following point about President Obama’s proposal to increase marginal tax rates for Americans with the highest income: the rich can afford to pay higher taxes, but raising tax rates will probably make them work less.  Upon reading this I thought to myself “finally, somebody who presents both sides of an argument.”

Rather than rehash Mankiw’s argument, in which he discusses the impact of taxes on his own incentives to engage in discretionary labor such as giving an additional invited lecture, I’ll let Mankiw’s piece speak for itself.  Although some are disputing his exact numbers (see Mankiw’s response here), the basic point is clear.  Rich people probably can afford to pay more in taxes.  But, we should not assume that just because rich people can afford to pay more taxes, that increasing taxes on the rich would be without costs.  In response, we should expect that these people will work less.  We’re probably not talking about Atlas Shrugged here, with the economy grinding to a halt, but we should expect that people will work less.  As with every policy, there are costs and benefits.

So, what is the right way to think about whether we should raise taxes on the rich as a way to close the budget gap?  Well, there are alternatives to raising taxes on the rich: we could reduce spending, raise taxes on everyone, or just continue to fund the government by issuing debt.  Each of these has its costs and benefits.  An intellectually honest approach to the problem involves carefully laying out the costs and benefits of each and deciding, based on overall social goals, which one does the best job.  To argue either that, just because the rich can afford to pay more they should pay more, or that just because higher taxes will reduce work incentives for the rich they should not be raised, is ideology, not economics.